Morgan Stanley said the Federal Reserve’s 25-basis-point rate hike last week matters less for the move itself than for the logic behind it and what it signals about the inflation path ahead.
In a new report, Morgan Stanley chief global economist Seth Carpenter wrote that the significance of the decision lies not in "what happened," but in "why it happened" and "where things go next." The bank’s view is that the increase looks more like a policy recalibration designed to preserve the disinflation process than the start of an entirely new tightening cycle.
After a 25-basis-point hike, Morgan Stanley shifts the focus to inflation dynamics
The Fed raised its policy rate by 25 basis points last week, the first increase in three years. Markets had already priced in the move and, in some cases, expected even more. Morgan Stanley had previously thought the Fed would probably stay on hold, based on inflation moving in the right direction and on the assumption that Chair Warsh would prefer to avoid hiking if possible.
That assumption did not hold. In the report, Morgan Stanley said a key measure cited by Warsh at Jackson Hole and again at the September press conference — the six-month inflation trend — was still moving lower, but not fast enough for the Federal Open Market Committee, or FOMC.
The bank also pointed to a renewed jump in energy prices as an added complication. Oil did not remain as contained as expected because of supply disruptions and the return of risk premia. Faced with a disinflation process that was slowing too gradually and with clear upside risks from energy, the FOMC chose to act.
Morgan Stanley says Warsh’s policy focus is the balance sheet, not just rates
Morgan Stanley said Warsh had made clear in public comments before his appointment that he saw the Fed’s balance sheet, rather than interest rates, as the reason inflation remained above target. Even so, the FOMC’s traditional rate tool is still dominating the policy response.
The report said monetary policy is decided by FOMC vote. A new chair has substantial influence, but cannot immediately remake that process. As early as the June dot plot, a sizable number of officials were already leaning toward more tightening. In July, three officials even cast dissenting votes in favor of a hike.
On that reading, the September increase was not simply Warsh’s personal choice. It also reflected the position of a majority inside the committee, with a meaningful share of members unwilling to declare victory over inflation too early.
The dot plot is a directional signal, not a precise forecast
Morgan Stanley warned against reading too much into the dot plot. The median projection currently points to only one more hike, while keeping open the option of a second.
The bank said the dot plot is best treated as a directional signal rather than a firm forecast. The message is that if inflation does not improve enough, the Fed is prepared to tighten further.
The report also said the distinction between voting and non-voting members next year will matter. Most of next year’s voters may prefer to push rates to a higher level.
The key question: how Warsh intends to deliver price stability
Morgan Stanley framed the debate around what it called the key question: how Warsh plans to achieve price stability.
According to the report, Warsh has consistently argued that the balance sheet is the core driver of inflation. Yet he made no mention of the balance sheet at all during the September press conference. Morgan Stanley said that tension strengthens the case that markets may be expecting more rate hikes than this Fed will actually deliver.
If Warsh’s working group completes its work and a balance-sheet reform plan is put in place, the need for aggressive rate hikes could drop materially, the bank said.
A recalibration, not a regime shift, with tightening likely near the low end of expectations
On the broader question of what the September hike means, Morgan Stanley’s answer is that it represents an adjustment within the current framework, not the opening of a new tightening cycle.
The Fed’s statement said the move was intended to bring inflation back to target in a "timelier" way. Morgan Stanley took that to mean the direction of inflation is still correct, but the Fed wants faster progress. That is not a declaration that earlier policy was fundamentally wrong. It is a change in degree.
The report added that markets often describe this kind of recalibration as removing last year’s "insurance cuts." Morgan Stanley also said the US economy can absorb these rate increases.
Overall, the bank said the Fed is more concerned about inflation and willing to act, but if disinflation continues as expected, the degree of tightening the central bank ultimately seeks should become clearer and is likely to land near the low end of what markets currently expect.
